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Honesty (about Your Costs) Is the Best Policy

Matt Palmquist

Matt Palmquist is a freelance business journalist based in Oakland, Calif.

 

Bottom LineBeing honest about the expenses that go into developing and distributing a product can increase sales and enhance a firm’s bond with consumers.

Revealing the costs of designing, producing, and distributing a product or service seems like a crazy marketing ploy. Historically, companies have closely guarded this information as a way to massage their profit margin and gain a competitive advantage over their rivals. But according to a new study, companies that lay bare their expenses can usually enhance their bond with consumers and significantly increase their sales as a result, above and beyond what more traditional marketing strategies typically achieve.

There tends to be one exception, the authors note: When a firm’s disclosures reveal that it is trying to take advantage of market turbulence—for example, if a hardware chain jacks up the price of snow shovels in the face of a fierce winter storm—consumers will likely turn on it.

Embracing cost transparency is a relatively new notion. But it’s becoming more relevant in an age when consumers increasingly crave, and can efficiently process, detailed information about their potential purchases. It differs from a similar openness about price—in which companies reveal how the money customers pay for a product gets funneled into revenue, royalties, and taxes—or disclosure of the mechanics behind a company’s production process.

Cost transparency is more relevant in an age when consumers crave information about their purchases.

In the first section of their study, the authors conducted six different experiments involving more than 2,500 participants who interacted with the website of a fictional T-shirt retailer. And they found that cost transparency had a profound effect upon consumers’ willingness to spend. Specifically, cost transparency proved more effective at increasing purchase intentions than the far more common (and expensive, and complex) strategy of emphasizing the personal connection between a consumer and a brand. The tactic also outperformed the operational transparency approach, in which participants received information about the production process required to make the T-shirts.

These positive effects endured even when consumers encountered information about costs they typically don’t like paying for; for instance, research has shown that consumers are much more tolerant of a company charging for raw materials than for logistics. But even when the transportation costs were relatively high, participants tended to opt for T-shirts that revealed cost information. Cost transparency really backfires only when consumers see that a company’s profit margin far exceeds the industry standard, the authors found. “Although consumers understand and accept that firms must make profits…they punish firms that violate established norms of price fairness,” the authors write.

They further validated these experimental findings using a real-world scenario. In 2013, just before Christmas, an online retailer sent an email to customers promoting a leather wallet that came in five different colors and cost US$115. Then, in an attempt to encourage post-holiday sales, at the end of January the company added an infographic to the product webpage for each of the wallet’s color choices. This infographic broke down the raw materials and process required to make the wallet, as well as the costs associated with each aspect of production, including the leather ($14.68), the construction ($38.56), and the transportation ($1). The company disclosed that the wallet had a 1.9x price markup, as opposed to a similar wallet offered by a rival that carried a 6x markup.

This enabled the authors to conduct a natural experiment, comparing how the sales of models differed depending on whether they had a cost breakdown on their product page. Strikingly, while the sales in general trended downward over the period, reaching a diminishing level after the holidays, wallets augmented with cost transparency information experienced less of a plunge. In fact, daily sales increased 44 percent after the implementation of the infographic, compared to those models without any cost transparency data.

Of course, despite the apparent benefits, certain firms could be discouraged from disclosing their costs by strategic concerns and contractual issues could discourage certain firms from disclosing their costs. Companies may want to keep their costs close to the vest if their access to cheap resources or a streamlined production process provides them with a crucial competitive advantage over their rivals. Similarly, a company’s suppliers and partners may not countenance the disclosure of their proprietary information.

Nevertheless, the authors write, “Relative to other marketing tactics, cost transparency might be an innovative and inexpensive way to build brand attraction and sales.”

Source: “Lifting the Veil: The Benefits of Cost Transparency,” by Bhavya Mohan, Ryan W. Buell, and Leslie K. John (all Harvard Business School), Social Science Research Network, Sept. 2014, Working Paper No. 15–017

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Honesty (about Your Costs) Is the Best Policy